Comparative Disadvantage

The heart of Samuel Gregg’s case against economic nationalism is an abiding faith in the theory of comparative advantage. So well does this theory guide national economic development on behalf of the national interest that interventions by policymakers can only make matters worse. His faith is misplaced.

“In the first place,” writes Gregg, “economic nationalism makes it harder for individuals, regions, and nations to discover their comparative advantage.” As an example, he suggests that “Israel may be able to produce more manufacturing goods and technology than Australia. It’s still, however, the case that Israel can obtain more manufactured goods from Australia by specializing in technology and trading some of that output for imported manufactured goods.”

This description is the “A” answer on an introductory economics exam. Comparative advantage allows trading partners, whether individuals or nations, to specialize where each has the lower opportunity cost, increasing total output and, through mutually beneficial exchange, leaving both with more to consume. The sooner that each side “discovers” its advantage and specializes accordingly, the sooner benefits can flow. By contrast, Gregg argues, a protectionist policy that interferes with trade in a free-market international economy, “gradually dulls a nation’s awareness of its comparative advantages.”

But the description bears no resemblance to how the international economy operates. Even the stylized example raises more questions than it answers. Israel is indeed an international technology powerhouse. But why? Is it simply in the nature of small, socialist agricultural communities founded by refugees and beset constantly by war and terrorism to become centers of innovation? Is it something about the Mediterranean winds, perhaps? Or, as the World Bank suggests, has it “been the Israeli government’s explicit goal to position Israel at the core of the knowledge economy.… There is broad agreement as to the significant role played by the government in the emergence and development of Israel’s vibrant and dynamic high-tech sector.”

Australia, for its part, might appear sensible to specialize in manufactured goods. The example conveniently provides only the desirable-seeming technology and manufacturing industries as candidates for specialization. What about kangaroo meat? Would Australia be wise to outsource all its technological needs to Israel so that it can focus on its own comparative advantage in marsupial herding? The theory assures us that, in year one, the Aussies will enjoy a greater bounty of software and ‘Roo-ribs than if it tried to develop software itself. But what sort of economic trajectory would the nation then travel?

The idyllic conception of an international economy in which countries all benefit from specializing in their discovered comparative advantages fails both because comparative advantage is not discovered and because specialization can backfire.